US Federal Reserve meeting comes after months of sticky CPI prints and one unexpected GDP growth slowdown, could rates fall soon?
The Federal Reserve Open Markets Committee (FOMC) meeting concludes tomorrow and at 2pm ET Fed Chair Jerome Powell will announce his benchmark interest rate decision. While at the start of the year, many had predicted that Powell’s promised interest rate cuts would be well underway by now, stubbornly high inflation has pushed the predicted schedule of cuts back significantly. After the US Consumer Price Index (CPI) rose again in March, markets are largely predicting that Powell will hold interest rates steady once again.
Experts weighed in on how Powell is viewing the US economy and the battle with inflation going into this meeting. They explored how Powell’s decisions might impact what the Bank of Canada decides to do with interests rates here and offered some guidance as to what investors may want to watch for at Powell’s press conference. The fundamental focus, however, remains on inflation.
“The upside inflation surprises over the last few months have narrowed the path for rate cuts that Powell had hinted at the end of last year, so I expect them to remain on hold” says Fernanda Fenton, VP & Portfolio Manager for Fixed Income at CI Global Asset Management. “I expect them to reiterate some of the more recent comments around what they require to feel more confident initiating a cutting cycle. I don’t expect them to abandon the disinflationary narrative, but just to hammer away their message that more evidence is needed to assess the sustainability of inflation and until the data reveals that they won’t be changing their interest rate path.”
US inflation has remained so sticky in part due to the resilience of US consumers, who have played a significant role in the country’s relatively strong GDP growth over recent months. Fenton notes other contributors to inflation, such as a relatively slow decline in shelter inflation and some higher than expected services inflation. Services inflation is a bit of a tougher area to predict, Fenton notes. Where goods inflation can be understood better through inventories and supply chains, services don’t come with the same degree of clarity.
US GDP growth surprised to the downside in Q1. The numbers released last week showed a growth rate of 1.6 per cent, far lower than expected. Fenton, however, does not think that number means that US consumption is giving way or that the Fed will cut to stimulate growth. She notes that a trade deficit was a significant contributor to negative GDP, which points to strong US consumption, just of imported rather than domestic goods.
“The recent data confirm my overall view of a resilient US economy with stubborn inflation. The details of the GDP data were better than the headline and consumption is still holding up well,” said Sonal Desai, CIO at Franklin Fixed Income. “With the upward revisions to January and February, the PCE data confirm that price pressures remain persistent. Inflation is not accelerating, but it is not coming down anywhere near as fast as the Fed would like.”
While some have expressed concern around the US heading towards stagflation, Desai says those concerns are premature. Her primary concern is whether the US’ recent acceleration in productivity growth will continue. Desai agrees with Fenton that a cut tomorrow is unlikely. She says that markets are now only predicting 1-2 rate cuts this year.
While US inflation remains stubborn and sticky, Canadian inflation has moderated somewhat prompting slightly more dovish language from Bank of Canada governor Tiff Macklem. Some analysts have said, however, that the Bank of Canada will wait for the Fed to cut before it cuts its own interest rates.
Fenton disagrees with that view. She believes that the BoC will act if economic conditions warrant and that even if the Fed remains on hold the BoC has room to cut. Looking back over the past 30 years she sees plenty of divergence between the two central banks and while the Fed’s rate will be part of the BoC’s analysis, it shouldn’t be the sole determining factor.
Powell’s press conference following tomorrow’s announcement may prove instructive for investors. For her part, Fenton is listening for Powell’s answer when he’s asked if the latest dot plot is still relevant. How Powell characterizes the dot plot, Fenton says, will validate markets’ decision to price out rate cuts since March.
As investors wait for signals of a cut and a shift away from our current high interest rate environment, Desai says that tempered expectations and preparedness for volatility may be the best way to operate.
“I also still believe this will be a short and shallow rate cutting cycle. Current market pricing seems broadly realistic in terms of the terminal rate. The data in my view continue to confirm that the current fed funds rate at just over 5% is not overly restrictive,” Desai says. “Volatility will remain elevated, however, with markets likely to overreact to both upside and downside surprises on inflation. I would expect that 10-year USTs will jump around in a 4.25-4.75% range. Over the medium term, after this shallow rate cut cycle is done, we are likely to see long end yields moving higher due to fiscal pressures.”
